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Charitable Trusts (Irrevocable Trusts)
If, in addition to providing for your family, you also want to support a charitable cause, you may employ one of the several types of charitable trusts available.
Charitable Remainder Trust (CRT)
The most common type used is called a charitable remainder trust. The family receives income for life or for a number of years, and a charity receives the remainder, hence the name. Typically, a CRT will provide benefits for the spouses’ lives, and at the death of the last one to die, the charity will receive the remainder. The highest level of benefit can be obtained by transferring a highly appreciated asset into the trust. If you sell an asset outright, you will pay capital gains tax on the gains realized. If the asset is sold after it’s transferred in the trust, the trust pays no capital gain and the spouses (the donors) receive income off of a larger amount than it would be with an outright sale where taxes need to be paid. Additionally, the donors receive an income tax deduction in the year they transferred the assets into the trust. As an added twist, donors who do not need income may assign their future income stream to the remainderman (charity) and receive significant deductions, especially when interest rates are low. One IRS ruling (PLR 200152018) allowed the donor to trade a CRT income interest for a charitable gift annuity (see below), freeing up some funds immediately for use by charitable remainderman (the one getting the assets after you’ve passed away) and preserving some income for the donor.
Let’s look at a real life example where you can actually help a not well off family member, charity and yourself. Suppose you are doing well and have a poor brother Mike. Suppose further that you have about $500,000 in highly appreciated real property and about $300,000 in highly appreciated stocks. You can fund a unitrust (more about this later) that pays about 6% income and assign (give to someone else) to Mary who is in a much lower income tax bracket than the “lucky” you. After Mary passes away the payments can go to you or another beneficiary.
There are two types of CRT’s: Charitable Remainder Unitrust (CRUT) and Charitable Remainder Annuity Trust (CRAT). CRUT provides yearly income to the donors or other beneficiaries as a percentage of the current value of the trust with 5% of the trust assets being the minimum distribution. Thus, this income will vary with the market conditions. When the last of the beneficiaries passes away the charity receives the rust assets and distributes them per the donor’s directions. The donors receive an income tax deduction equal to the present value of the charity’s remainder interest in the initial value of the trust. Typically, CRUT is chosen if your remaining life span is long and you want to benefit from the growth of the principal and income. Additions are allowed once the trust is set up.
Standard CRUT is best used when the income payments are expected almost immediately. It is typically not used for transferring real estate.
The Income-Only CRUT pays fixed percentage income and only when the trust actually earns income.
The NIM CRUT - in addition to paying income when earned, it also has a make up provision to pay the payments foregone in the previous years.
Charitable Remainder Annuity Trust (CRAT) pays income similarly to the CRUT, except that the payments are based on the fixed percentage of the trust’s initial value. Thus, this income does not fluctuate, i.e., the donor will receive fixed income but will forego any benefit from the growth of the trust and will also avoid any losses. A possible serious disadvantage is that no additional contributions may be made after the trust us funded.
In Grantor Retained Annuity Trust (GRAT) the grantor receives income from the trust for a period of years and the property then passes to a donee. The gift value is adjusted down per the IRS rules to allow for the grantor’s retained income interest.